By Kent Atkinson of NZPA
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Friday 8th October 2004 |
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For the nation's biggest business, Fonterra Co-operative Group, this special characteristic of its 12,200 farmer shareholders is a two-edged sword.
Every one of its supplying farmers relies heavily on the productivity and growth of the company for both their day-to-day income, and much of their earnings from off-farm investment.
This naturally results in an intense focus by shareholders on what their company is doing, and what that will mean for their individual earnings and investments -- a level of scrutiny usually not seen in city-based corporations, at least at levels below institutional investors.
Add into the mix a constitution that effectively says 75% shareholder approval is required for any significant structural change, and the need for high levels of transparency and understanding among shareholders becomes crucial.
This was driven home to Fonterra in September last year, when the co-operative tried, and failed, to change its system of selling "peak notes" at $30/kg of milksolids to fund processing capacity for extra milk at the peak of the milking season. It won only 68% approval from farmers.
Most New Zealand milk is produced from pasture-based farming systems, which means milkflows usually peak with summer grass growth. Each of the company's 12,200 shareholders have to hold one Fonterra share for every 1kg of milksolids they supply. But the company provides for shareholders that exceed the average seasonal supply patterns by selling them "peak notes" at $30 each, for each 1kg of extra milk produced at the peak of the season.
Money farmers pay for peak notes is used to build the extra processing capacity. Most farmers regard the system as unnecessarily complex.
Meanwhile, by June of this year, chief executive Andrew Ferrier was saying the co-operative might need more "flexibility" from its farmer shareholders in funding future growth.
Fonterra had a "massive opportunity" to build on its competitiveness and low-cost position long term to create strong relationships with the world's major food companies, but making full use of the company's assets, infrastructure, institutional capacity and intellectual property would require finding the right funding solutions.
"While Fonterra can fund the immediate needs of the cornerstone activities and current options within our existing balance sheet, as the business evolves this may not always be the case," he said.
A change of capital structure could provide Fonterra with access to new pools of capital either from shareholders or, in some cases, from external investors.
The concept was not new - in May, 1999, the Dairy Board's then chairman, John Storey, said when he first announced strategic planning for the creation of Fonterra, that a key issue would be provisions for any future need to raise external equity.
And the Australian consultants who advised on the Fonterra merger, McKinsey and Co, estimated that farmers would be able to provide about $8 billion of the $12 billion funding Fonterra would require through to 2009, and that the balancce would have to be found from other sources.
Ferrier said farmers were not so conservative that they would not countenance change, but first they needed to agree the change would be in their best interests: "Any change to the fundamental principles of how farmers provide capital to the co-operative will require 75% of them to be absolutely convinced that any alternative is better.
"One does not go out to challenge a fundamental principle of co-operative ownership without preparing a compelling argument," he said.
What he did not directly say was that just because a farmer has invested a million dollars into cows, land, a dairy shed and Fonterra shares, that does not automatically make them a sophisticated investor with a clear understanding of capital structures.
Yet, if the company's control of 40% of global dairy trade and $11 billion in assets is to provide long term wealth growth for shareholders , its farmers will have to repeatedly confront future calls to fund growth.
This will be particularly important in adding value by expanding its fast-moving consumer goods arm, NZ Milk.
And in the near future, rationalisation of the Australian industry will raise the issue of finding capital to fund acquisitions, while Fonterra's planned purchase of a big stake in Chinese company Sanlu may need to be supplemented simply to keep up with the surging growth of dairy consumption there.
Eventually, Fonterra's partnership with Nestle in Central and South America will turn its attention to hugely expensive investment in dominating the chillers of United States and Canada supermarkets.
So Fonterra has started seriously investing in ensuring its farmer shareholders understand the major issues facing the business .
Co-operative chairman Henry van der Heyden says Fonterra will go to its 12,200 farmer-shareholders in late November or early December with some possible solutions for "emerging tensions" over its future capital structure.
It will seek farmer feedback early in 2005, and will hold a special general meeting in the middle of the year to make decisions.
Van der Heyden has emphasised that though Fonterra's capital structure needs to change with the business, the "capital structure's not on the agenda because Fonterra actually needs capital".
Some farmers have expressed concerns about the high cost of Fonterra shares in proportion to milk payouts, and suggested it would be better for more capital to be returned directly to farmers rather than being held by the company to re-invest in global expansion.
Others have said Fonterra must invest in its global brands but that the present capital structure may be holding that back.
An important initial step for Fonterra has been to reach agreement with shareholders on three immutable pillars to Fonterra's structure: that Fonterra remains a farmer owned co-operative, that it continues to be the lowest-cost mass producer of dairy products in the world and that it continues to expand its value-added business.
Ferrier's predecessor as chief executive, Craig Norgate, told an international dairy conference in Paris two years ago that the company was grappling with the potential for New Zealand Milk to raise capital from outside the existing farmer shareholders, but noted: "We are conscious that not all our shareholders have the same appetite for investment."
Shareholders' Council chairman John Monaghan has said there is appetite for some change, but that it will be an evolutionary process rather than revolutionary,
According to van der Heyden, the potential for spinning off NZ Milk will be considered but it is not a likely option. And any possibility of a stockmarket listing for Fonterra as a whole was not a part of the current debate - it would remain a co-operative.
But the co-operative and its farmers did need to discuss issues related to capital structure which were starting to create "tensions", such as:
According to van der Heyden, Fonterra needs defensive mechanisms to mitigate competitive risk from rivals such as Wyatt Creech's just-launched Open Cheese Company: " They are knocking on the doors of our farmers that have the flattest milk curves... and the farmers closest to the factories," he said.
The Fonterra board will use continuing farmer interest in getting rid of peak notes - by giving pricing signals for the different shapes of milk production curves - as a peg on which to hang next month's proposals for changes to capital structure.
"We would like to have a capital structure that is a lot more simple than what it is now," van der Heyden said.
As part of this restructure, the co-operative would need to stop collecting capital, through peak notes, for building extra processing capacity at the height of the season, and instead pay farmers less for the "extra" milk which brought about the need for those extra processing plants.
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